Zynga Absorbs Secondary; But Analyst Sees Huge Risks

Zynga shares are doing just fine Thursday after the company last night priced a secondary offering of almost 43 million shares at $12 each, with all of the stock coming from selling holders. While priced slightly below yesterday's closing mark of $12.24, the stock today nonetheless is trading slightly into the green. That's an impressive performance which supports Zynga's decision to allow insiders to sell in an underwritten offering rather than waiting for an unorganized wave of selling on the expiration of the social gaming company's post IPO lock-up period.

But is the current level sustainable? Sterne Agee analyst Arvind Bhatia this morning repeated his Sell rating and $7 target on the stock, asserting bluntly that the current valuation is simply not logical.

For one thing, Bhatia contends that average daily active users for the company's games on Facebook has been flat sequentially in Q1, despite the addition of three new games, including Hidden Chronicles, Zynga Bingo and Zynga Slingo. Ex those games, he says, and DAUs were down 14% from the December quarter. He says that daily active users fell 18% for Farmville and 25% for Cityville.

The analyst notes that mobile DAUs were up in the quarter, but that monetization on mobile is much lower tha on Facebook. "After the initial purchase of the game for 99 cents (or a free, ad-supported version), we believe few users make additional in-game purchases and those that do tend to spend small amounts of money," he writes.

Not least, he contends the stock is simply trading at a statistical premium to peers that can't last - he notes that the stock trades at a premium to peer Internet companies, and that even after the offering today there remains a large number of shares that are due to be freed up from current lock-up agreements. He thinks the result will be multiple contraction.

"In addition, we believe, there is some scarcity premium built into ZNGA shares as investors use it as a proxy for Facebook," he writes. "With the anticipated IPO of Facebook in the next 60 days, we believe such premium will erode."